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International Herald Tribune: Russian government gains another concession on Sakhalin-2 project

By Andrew E. Kramer
Thursday, December 28, 2006


The Russian government has won a further concession from the foreign partners at the world’s largest combined oil and natural gas field, known as Sakhalin-2, which is being developed in Russia’s remote Far East.

Last week, Gazprom, the Russian energy monopoly, took majority control of the project when the foreign developers, led by Royal Dutch Shell, agreed to sell 50 percent plus one share to Gazprom, after months of pressure on the company and accusations from a Russian environmental regulator. Critics called the sale a forced nationalization.

The latest twist came Thursday, when the Russian government said that the three private partners had given up their right to recoup $3.6 billion in capital expenses on a priority basis. They were supposed to recoup all that before the government began collecting sizable royalties.

The slower repayment further devalues the foreigners’ investment, though it is unclear by exactly how much. And it benefits the government, which through Gazprom has been tightening its grip on the oil and gas business in Russia, while also growing more ambitious in the countries where it supplies energy.

In the sale announced last week, Shell cut its stake in Sakhalin-2 in half, to 27.5 percent, and the two Japanese trading houses partnered with it also cut their holdings by that degree. Mitsui’s holding fell to 12.5 percent, and Mitsubishi’s went to 10 percent. Gazprom agreed to pay $7.45 billion, a price that analysts said was below market value.

Russia is impelling other foreign oil investors to renegotiate deals made in the 1990s, often under regulatory threat.

For instance, also Thursday, Viktor Vekselberg, who owns part of the British-Russian joint venture TNK-BP, met with Gazprom’s chief executive, Aleksei Miller. Russian regulators have threatened to revoke the TNK-BP license to a large Siberian gas field, Kovytka, at the same time that Gazprom is negotiating for a stake in the project.

The agreement to delay compensation for capital expenses at Sakhalin-2 was not announced in the accord last week but was included in a confidential protocol signed by the foreign partners and the Russian government. A Russian deputy minister of energy and industry, Andrei Dementiev, disclosed the protocol in an article Thursday in the business daily Vedomosti. A ministry spokeswoman confirmed that account.

According to the original contract with Shell, signed in 1994, the government would get low royalties until the foreign partners recovered all their capital costs. Afterwards, over time, the government’s share would rise.

The change made public Thursday means that the companies will not recoup their costs upfront. That gives the government a bigger take without formally renegotiating the production sharing agreement. To change that governing document would take an act of Parliament.

The government said it would approve a budget of $19.4 billion for the next stage of development, stipulating that the partner companies would not begin to recover $3.6 billion of this before the government begins collecting meaningful royalties, Vedomosti reported. The government was evidently anxious that under the former terms, high development costs would keep it from getting bigger and faster royalties.

A Shell spokesman, Maksim Shoob, declined to comment on the report, citing its confidentiality agreement with the Russian government. “The protocol between Sakhalin shareholders and the Ministry of Energy and Industry is confidential and we will never breach any confidentiality agreement,” Shoob said.

The project, north of Japan, includes offshore platforms, 500 miles, or 800 kilometers, of oil and natural gas pipelines, a liquefied natural gas plant and an oil terminal. It is supposed to begin production in 2008.

The three partners have sunk about $12 billion into Sakhalin-2. The terms announced last week meant that they would recoup only about half their capital investment so far, and in addition would be compensated little for the four billion barrels of reserves estimated to be recoverable at the site. But last week in Moscow, at the ceremony where President Vladimir Putin of Russia announced the new terms, Shell made the best of the situation.

Its chief executive, Jeroen van der Veer, said Shell needed to operate in a stable environment after a Russian regulator caused months of turmoil by threatening to halt work on the pipeline, claiming illegal logging and damage to salmon streams. “Now there is stability,” van der Veer said, “so we can all work together, all the shareholders, to get the project up and running as soon as possible.” and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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